The New Arthurian Economics

Saturday, October 8, 2016

2 October 3:29 am, downloading the MacroAdvisers' monthly GDP dataset. Data now thru July 2016. Last I looked was thru May. Where do we stand now?

Graph #1

The blue is the monthly data. The red is the Hodrick-Prescott. As you can see, in 2014 and 2015 the blue was mostly above the red, pulling it up; and in 2016 the blue has been mostly below the red, pulling it down.

The red line on Graph #1 uses a large "smoothing constant", so the line is smoothed a lot. Not only does the smoothing temper the jiggies of the past few years; it also takes out most of the Great Recession and much of the initial recovery. The H-P calculation for this graph does too much smoothing to suit me.

The value 14400 is a "standard" smoothing constant for monthly data. (I got it from trubador at the E-Views Forum.) I use it as a starting point, but it doesn't always give me the smoothing I want for a particular graph.

The standard for quarterly data is 1600; the smaller number provides less smoothing:

Graph #2

In Graph #2 the red line follows the general path of the blue somewhat better than #1. Unfortunately, the downtrend of recent months is worse looks worse. In Graph #1, the blue jiggies vary over a red trend line that is nearly flat. In #2, the trend line takes more slope from the jiggies. If it was an up-slope we'd be ecstatic. But it's a down-slope, and it is discouraging.

Blithely moving on, then, let's add some more jigginess to the trend. This time I'll use the constant that's a standard for annual data:

Graph #3

Now the red line follows the blue into the depth of the Great Recession and the peak of the initial recovery. And throughout the graph the red line shows what appears to be a good centerline, the central path for the blue. If we were looking at 50 years of data this graph might have too much jigginess in the red line. But we're looking at only a few years. The red line provides useful information.

Unfortunately, the trend is still definitely down since 2015. But I think I see the down-trend slowing in #3, where it was picking up speed in #2.

Over the last six months or so, the blue line shows a pretty well-formed "W" shape. The trend of the "W" would certainly be flat. It would be low (lower than the red for most of the last several years) but more flat. Not so much downhill. That's a plus.

For what it's worth, there is more hope of economic improvement in Graph #3 than in #1 or #2. But you know, the blue line is the same for all three graphs. It displays the source data that is used by all of the red lines. So you can pick whichever trend you prefer, and tell whatever story you want about the future, but it is only a story. And it won't be the story that the source numbers tell.

The source numbers don't tell us about the future. They only tell us about the past. Our fascinations lead us to tell stories about the future. Our attitudes color those stories.

If I reduce the smoothing still further, I can show you the red line flattening out in the last few months:

Graph #4

Now you could draw a flat line, extending the red line out to the right. Or, for that matter, you could extend the red line by continuing the curve upward, similar to what happened after the mid-2011 low and the early 2013 low.

You could even make the red line curve down more, I suppose. It's mostly attitude.

There is a subset of people who happen to think that what happens in the economy depends on what happens with money. I'm in that group, for sure. A subset of that subset thinks that what happens with money depends on what happens with base money. At the Federal Reserve, it's their job to be in that group.

It's easy enough to add base money to the graph we've been looking at. So that's what I did. Base money in black:

Graph #5

RGDP growth, red or blue, is mostly in the neighborhood of 2%. Base money growth, black, is mostly in the neighborhood of 20% (on the right-hand scale). Base goes high around the Great Recession (near 100%) and RGDP goes low.

I'm going to say that the ups and downs of the black line on Graph #5 have something to do with the policy called Quantitative Easing. I want to test for a relation between those ups and downs and the growth of RGDP.

On #5, RGDP (look at the red line) bottoms out in early 2009, just as base money growth (black) is peaking. The red line bottoms out again in mid 2011. Again the black line peaks at the same time.

The red line bottoms out for the third time in early 2013. This time the black peak comes later, in late 2013. Looks like it tried to peak when the red line was bottoming out, but events must have required additional quantitative boost from the Fed.

After that third and final peak in the black line, base money growth tapers off.

The path of the black line shows the Quantitative Easing policy being applied in response to economic conditions. This is the reason the peaks in the black align so well with lows in the red.

So much for policy's response to the economy.

What about the economy's response to the policy? To see that, we have to lag the black line, the policy line. If I lag it 15 months, the red and black peak together:

Graph #6

I like to think this shows that it took the economy 15 months to respond to the Fed's first quantitative easing.

But if you look at the second black peak on #6, the 15-month lag is too much. The graph shows the black line peaking after the red. When I reduce the lag to eight months, these two peaks align:

Graph #7

I like to think that the economy took 15 months to respond to the first black peak, but only 8 months to respond to the second. The second lag was only half as long. This would mean that the "metabolism" of the economy was picking up and the economy was improving. If I was the Fed, I would have said QE is working.

Look at the low point before the second black peak. It lines up well with the low in the red line. So the same 8-month lag applies at that low as at the second peak -- and presumably during the rise to the second peak as well.

But now look at the decline from the second peak. The black line appears to bottom out a couple months before the red. This suggests that the economy's "metabolism" had slowed again. That is plausible, as the decline of the red is itself an indication of slowing.

Perhaps that unexpected reversal is responsible for the wiggle of the black line visible in the early months of 2014 on #7. It looks as if the Fed had already decided to bring the increase to a peak in those early months, but suddenly the Fed changed its mind and pushed the black line up again, to a higher peak.

The same wiggle appears in the same place, on the red line. But it look longer for that wiggle to play out in red. Again, this indicates a growing lag.

Of course, the black line on Graph #7 is shown with an eight-month lag. So those early-2014 wiggles actually occurred about 8 months apart.

The third and final peak in the black line comes well before the third red peak on #7. The alignment is better with a 15-month lag, as shown on Graph #6.

The longer lag implies a slowing economy.

This brings us to the final down-slopes shown on the graph: It looks like the downtrend in RGDP growth has been encouraged by the downtrend in base money growth. Let's look at that.

After the third and final peak, the black line trends down. The red does the same. After the red line ends, the black line continues downward to the end. The lagged data lets us imagine the future of RGDP:

Graph #8: The same data as Graph #6. Our window on it is different.

If the downtrend in RGDP growth is related to the downtrend in base money growth, then we should expect RGDP growth to trend downward for another 15 months. That can't be good.